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Cisco Earnings Rundown

November 9, 2010 By Steven Place

Cisco Systems (CSCO) reports tomorrow after the market close. I'm looking to potentially do a trade, but wanted to put some analysis out there. Structuring trades around earnings can often be a difficult task, but you can learn about it here.

Historical Bias

Now what makes this particular earnings event interesting is the earnings prior. CSCO is not the most volatile of names, and it generally doesn't see large gaps into earnings. But when they reported in August, it created a huge gap, and the options market got it completely wrong-- it was the worst gap down since at least 2002.

Overpricing the move?

What I often see is after a huge move after earnings, the report after that move will often have a large premium priced in options. That is because option traders do have a memory, and they overprice the potential gap risk.

Looking at the weekly options, we can see the options market is pricing in about a 4.3% move by Friday. So that means as long as CSCO stays under 25.61 and 23.51, the option shorts will make money.

Comparing that expectation to the previous earnings event, it's slightly higher by about .05%. So it seems that the options market is expecting a normalization in terms of earnings volatility-- it's not expecting a huge 9% gap down again.

Have the market makers learned their lesson? Most likely CSCO won't see another gap like that, but it is interesting that the perception of risk is about the same-- and it may be due to overall market environment rather than overt earnings risk.

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